Compass pointing the right way

The economic backdrop is still tough but Compass - the world's largest contract caterer - shows every sign of emerging from these troubles relatively unscathed. The group's trading update last month reported a resilient performance, with underlying earnings - stripped of a fairly hefty £120m currency gain - expected to have grown by an impressive 14 per cent in the year to end-September 2009.

That resilience largely reflects a wider structural shift towards more outsourcing. Essentially, given the ongoing drive to keep costs down in both the public and the private sector, organisations increasingly outsource such areas as running their own canteens and despite the recession - or perhaps because of it - that has meant an impressive flow of new business for Compass. "Throughout the year the level of new contract wins and underlying [customer] retention has remained strong across the business," remarked management with the trading update.

In continental Europe, for example, those new contracts were with such customers as Société Générale and Coca-Cola. While in north America - which is responsible for generating 44 per cent of the group's revenues - Compass managed to sign new contracts within the education and healthcare sectors. And in the UK and Ireland, Compass renewed a number of major contracts - including with BSkyB, Heinz and the Royal Military Academy at Sandhurst.

But, as well as winning new business on the back of the rest of the world's desire to keep costs down, Compass is doing a pretty good job of cutting the fat itself. For example, with the group's half-year figures in May, management said that Compass's efficiency programme had delivered £50m of cost savings and last month's trading update reported further progress. "Efficiencies are driving profit margin growth and this will continue into 2010," says Tony Shepard, an analyst at stockbroker Charles Stanley. In fact, management reported in its trading update that the profit margin improvement will be approximately 0.6 of a percentage point for the year to end-September, with a 0.7 point improvement anticipated in the fourth quarter alone.

The group's balance sheet isn't in bad shape, either. Compass's £1.26bn net debt pile, for example, generated a £65m finance cost in the first half of 2008-09, but that looks eminently manageable when set against the group's half-year underlying operating profit of £445m. Compass is a strong cash generator, too - free cash flow grew 33 per cent to £240m in the year to end-March. And with about £800m of undrawn borrowing facilities, which are committed through to 2012, the group should have access to enough funding to support growth. That could include further bolt-on acquisitions, such as January 2009's $75m (£47m) purchase of US support services company Kimco, which bolstered Compass's business and industry operations.

That said, Compass has not entirely side-stepped the recession. For example, management says that the more cyclical operations - essentially the group's business and industry and sports and leisure divisions - have been hit by rising unemployment and lower levels of discretionary spending. The business and industry unit is the group's largest and generated 45 per cent of total revenues at the half-year stage. That helps explain why management expects Compass's organic revenue growth to be "broadly flat" for the full-year. In fact, broker Charles Stanley thinks that Compass's organic revenue growth could even be negative in the first quarter of 2009-10.

But that sluggishness looks like it will be nothing more than a short-term problem. In the longer term, Compass looks well-placed to continue to benefit from both a structural shift towards outsourcing and, as the world emerges from recession, an upswing in demand more generally. Those prospects have been enough for analysts at Numis Securities to forecast that Compass's earnings per share will rise by a decent 7 per cent in 2009-10 and by 8 per cent in 2010-11 (see table). A dividend yield of 3.5 per cent, based on Numis Securities' forecast of a 13.8p payout in the year just started, is acceptable enough, too, given that Compass's shares might be considered more a growth stock than an income play.